{"id":52531,"date":"2014-06-10T06:26:26","date_gmt":"2014-06-10T10:26:26","guid":{"rendered":"http:\/\/countingpips.com\/?p=52531"},"modified":"2014-06-10T06:26:26","modified_gmt":"2014-06-10T10:26:26","slug":"thoughts-from-the-frontline-can-central-planners-revive-chinas-economic-miracle","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2014\/06\/thoughts-from-the-frontline-can-central-planners-revive-chinas-economic-miracle\/","title":{"rendered":"Thoughts from the Frontline: Can Central Planners Revive China\u2019s Economic Miracle?"},"content":{"rendered":"
June 10, 2014<\/div>
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By John Mauldin<\/span><\/h4>\n
\"\"For years, when asked whether I thought China would experience a hard landing, I would simply answer, \u201cI don’t understand China. Making a prediction would be pretending that I did, so I can\u2019t.\u201d The problem is that today China is the most significant macroeconomic wildcard in the global economy. To understand both the risks and the potentials for the future you have to reach some understanding of what is happening in China today. Last week we started a two-part series on what my young associate Worth Wray and I feel is the significant systemic risk that China poses to global growth.<\/p>\n

The first thing in my inbox this morning here in Tuscany was a note from a friend about the growing scandal in Quingdao. For a long time many of us have known that there has been \u201cdouble counting\u201d in the commodities trade sector in China, where local \u201centrepreneurs\u201d create multiple warehouse receipts on which to borrow money cheaply, and then invest in what are essentially subprime securities that pay higher rates. Everyone \u201cknows\u201d that the government is not going to let anyone lose money on investments, so what could possibly go wrong? It turns out that Chinese warehouse officials are now emigrating in significant numbers to parts unknown around the world, armed with only their passports and whatever money they made through producing such bogus receipts. My sources suggest that the size of the problem is approaching $1.3 billion (far greater than the number being bandied about in public reports). Since one of the guiding principles operative in any scandal is that there is never just one cockroach, I expect the ultimate losses to be far larger. And it appears that the People\u2019s Bank of China is finally going to let people lose money on these fraudulent schemes. Good for them. But to suggest there is no risk in cleaning up corruption and fraud misses the point of our own subprime crisis. In a world where global economic trade and international banks are so intricately linked, trying to determine the actual risk to the system is difficult. And as I will note in my \u201cfinal thoughts\u201d section, corruption is a very real issue.<\/p>\n

We are going to try gamely to finish with China today, having left at least three or four letters worth of copy on the editing floor. There is just so much information and misinformation to cover. I\u2019m going to turn it over to Worth and then follow up with a few final thoughts of my own. (Please note that this letter will print exceptionally long as there are a number of charts and other graphics.) Now let\u2019s do a deep dive into part two.<\/p>\n

<\/a>Can Central Planners Revive China\u2019s Economic Miracle?<\/h2>\n

By Worth Wray <\/strong><\/p>\n

In my Thoughts from the Frontline<\/em> debut this past March (\u201cChina\u2019s Minsky Moment?<\/a>\u201d), I highlighted the massive bubble in Chinese private-sector debt and explored the near-term prospects for either (1) a reform-induced slowdown or (2) a crisis-induced recession. Unfortunately, it was not an easy or straightforward analysis, considering the glaring inconsistencies between \u201cofficial\u201d state-compiled data and more concrete measures of all real economic activity, which is why I suggested that China is simultaneously the most important and most misunderstood economic force in the world today.<\/p>\n

With the stakes now higher than ever, I returned to Asia\u2019s \u201cmiracle\u201d last week (\u201cLooking at the Middle Kingdom with Fresh Eyes<\/a>\u201d) and probed deeper into the shadows (including China\u2019s shadow banks) with the help of my new friend Leland Miller and a few illuminating excerpts from his Q1 2014 China Beige Book<\/em> (the largest and most comprehensive survey series ever conducted on a closed or semi-closed economy)<\/strong>.<\/p>

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Pulling back the Bamboo Curtain, Leland\u2019s data revealed aspects of the Chinese economy that John and I could have only guessed at before, giving us a rare opportunity to explore regional contrasts in Chinese economic activity, to survey the modest (but still insufficient) rebalancing among sectors, and to identify a series of pressure points within the credit markets that suggest last summer\u2019s interbank volatility may return in 2014.<\/p>\n

Unfortunately, Leland\u2019s key insights confirmed our fears that China\u2019s consumption-repressing, debt-fueled, investment-led growth model is slowing down and starting to sputter\u2026 but not collapsing (at least not yet). <\/em><\/strong><\/p>\n

What happens next \u2013 with huge implications for global markets \u2013 depends largely on the economic wisdom and political resolve of China\u2019s central planners, who must find a way to gradually deleverage overextended regional governments and investment-intensive sectors while also rebalancing the national economy toward a consumption-driven growth model.<\/p>\n

Finessing the challenges will require not just one but a series of miracles.<\/p>\n

<\/a>Like Every Other Investment-Driven Growth \u201cMiracle\u201d <\/strong><\/p>\n

After 34 years of booming economic growth averaging over 9% per year (the longest sustained period of rapid economic growth in human history), China\u2019s credit-fueled, investment-driven growth model is exhausted and increasingly unstable. As you can see in the chart below, the Middle Kingdom\u2019s credit boom is well past the point of diminishing marginal returns; and no one can deny that the misallocation is widespread, with capacity utilization now below 60%.<\/em><\/strong> (I should also note that Societe Generale\u2019s Wei Yao has consistently published some of the best research on China in recent quarters; personally, I won\u2019t be surprised to see her vault to rock-star status as the People\u2019s Republic decelerates.)<\/p>\n

\"\"
\nSource: Wei Yao & Claire Huang, \u201cSG Guide to China Reform.\u201d Societe Generale Research, May 14, 2014.<\/span><\/p>\n

Moreover, state-perpetuated distortions in the cost and availability of financing are (1) funneling huge amounts of capital toward increasingly unproductive, state-directed investments, and (2) pushing household and private business borrowers into the shadows, where the burden of substantially higher interest rates drags on household consumption.<\/p>\n

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\nSource: Wei Yao & Claire Huang, \u201cSG Guide to China Reform.\u201d Societe Generale Research, May 14, 2014.<\/span><\/p>\n

It doesn\u2019t require much imagination to connect the dots. Structural distortions in Chinese financial markets are a major cause of debt-fueled overinvestment; and without sweeping structural reforms (along with a major crackdown on corruption at all levels of government), captive capital will continue to flow toward unproductive investments, capacity utilization will continue to fall, and China\u2019s investment boom will continue its march toward a mega Minsky moment.<\/p>\n

This kind of structural distortion is a classic symptom of an overextended investment boom and a warning sign that rebalancing \u2013 whether it\u2019s induced by voluntary reforms or an involuntary debt crisis \u2013 will not be easy. The critical adjustments \u2013 gradual deleveraging and structural rebalancing \u2013 will require a greater slowdown in economic growth and a sharper fall in still-bubbly asset prices than China\u2019s policymakers are letting on.<\/p>\n

\u201cThis is not an easy task,\u201d The Daily Telegraph\u2019s<\/em> Ambrose Evans Pritchard says, in a truly brilliant article<\/a> published this week, \u201cnot least because land sales and taxes make up 39% of state revenue in China, and the property sector employs 20% of workers one way or another. It is clearly a bubble of epic proportions and already losing air. Mao Daqing from Vanke \u2013 China\u2019s top developer \u2013 says total land value in Beijing has been bid up to such extremes that is on paper worth 61.6pc of America\u2019s GDP. The figure was 63.3pc for Tokyo at the peak of the bubble in 1990.\u201d Yikes.<\/p>\n

As Peking University professor Michael Pettis explains in his 2013 book, Avoiding the Fall: China\u2019s Economic Restructuring<\/em><\/a>, \u201cEvery country that has followed a consumption-repressing, investment-driven growth model like China\u2019s has ended with an unsustainable debt burden caused by wasted debt-financed investment. This has always led to either a debt crisis or a lost decade of very low growth.\u201d<\/p>\n

China\u2019s \u201cmiracle\u201d is no different from any other investment-driven growth binge where high levels of leverage (directly or indirectly paid for by the household sector), combined with high levels of fixed investment, eventually result in excessive and unsustainable debt loads. Pettis elaborates:<\/p>\n

While these policies can generate tremendous growth early on, they also lead inexorably to deep imbalances. As demonstrated by the history of every investment-driven growth miracle, including that of Brazil, high levels of state-directed subsidized investment run an increasing risk of being misallocated, and the longer this goes on the more wealth is likely to be destroyed even as the economy posts high GDP growth rates. Eventually the imbalances this misallocation created have to be resolved and the wealth destruction has to be recognized. What\u2019s more, with such heavy distortions imposed and maintained by the central government, there is no easy way for the economy to adjust on its own\u2026. [Furthermore], Beijing [will] not be able to raise the consumption share of GDP without abandoning the investment-driven growth model altogether.<\/p>\n

In other words, the world\u2019s second largest economy is approaching its debt limit and the end of the line for investment-led growth\u2026 but China\u2019s financial system is structurally designed to prevent capital from flowing freely toward more productive uses. One way or another, the world\u2019s largest contributor to global economic growth must slow down \u2013 either because Beijing has the foresight, resolve, and political capital to pursue aggressive economic and financial market reforms or because party elites fail to address the country\u2019s structural imbalances and policy-induced distortions before the credit bubble pops. \u201cDebt,\u201d Pettis explains, \u201cas we will learn over the next few years in China, has always been the Achilles\u2019 heel of the investment-driven growth model\u2026\u201d<\/p>\n

<\/a>Which Way to Sustainable Growth?<\/strong><\/p>\n

Among the various reforms set forth in last November\u2019s Communist Party Third Plenum, ranging from financial liberalization to a crackdown on corruption and pollution, the most challenging is the gradual deleveraging of the Chinese economy while simultaneously rebalancing the national economy toward a more sustainable, consumption-driven growth model.<\/p>\n

To continue reading this article from Thoughts from the Frontline \u2013 a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics \u2013 please click here.<\/a><\/p>\n

Important Disclosures<\/a><\/p>\n

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The article Thoughts from the Frontline: Can Central Planners Revive China\u2019s Economic Miracle?<\/a> was originally published at mauldineconomics.com<\/a>.<\/div>\n
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By John Mauldin For years, when asked whether I thought China would experience a hard landing, I would simply answer, \u201cI don’t understand China. Making a prediction would be pretending that I did, so I can\u2019t.\u201d The problem is that today China is the most significant macroeconomic wildcard in the global economy. To understand both […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-52531","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/52531","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=52531"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/52531\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=52531"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=52531"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=52531"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}